Israel Cut Again by Moody’s Due to Economic Impact of War

(Bloomberg) — Israel’s rating was downgraded for the second time this year by Moody’s Ratings as the economic cost of the nearly 12-month war in Gaza and the escalating conflict with Hezbollah mounts.

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Moody’s downgraded Israel two notches from A2 to Baa1, leaving the country three notches above its non-investment rating, the ratings company said Friday. The outlook remains negative.

“Geopolitical risk has intensified significantly further, reaching very high levels, with material adverse consequences for Israel’s creditworthiness in both the near and long term,” Moody’s said in an unscheduled announcement. “The intensity of the conflict between Israel and Hezbollah has increased significantly in recent days.”

Even as the intensity of the fighting eases, there is little sign that the war against Hamas will end. Israel has significantly increased its hostility towards the Lebanon-based militant group Hezbollah over the past two weeks, and fears of a potential land invasion and regional conflict are growing.

The United States, France and Arab states are frantically stepping up their diplomatic efforts to prevent this scenario.

Ministry of Finance Accountant General Yali Rothenberg described the downgrade as “excessive and unfair.”

“The intensity of the rating action taken does not match the financial and macroeconomic data of the Israeli economy,” he said. “It is clear that the war on various fronts has taken a toll on the Israeli economy, but there is no justification for the rating company’s decision.”

Moody’s decision came before Israel struck Hezbollah’s headquarters in south Beirut on Friday, the heaviest attack on Lebanon’s capital in almost two decades. This development, which represents a major escalation of hostilities, could further intensify the violent multi-front conflict in the Middle East, at least temporarily.

The conflict turned out to be costly to Israel financially. While sectors such as tourism, agriculture and construction are declining, public expenditures and budget deficit are increasing rapidly.

Israeli officials estimate that the cost of the conflict by the end of next year will be roughly $66 billion, or more than 12 percent of gross domestic product. This figure was based on the fact that the conflict with Hezbollah did not escalate into an all-out conflict.

Israel’s budget deficit for the last 12 months stood at 8.3% of GDP in August. The country’s full-year fiscal deficit is expected to be the widest this century, excluding the Covid-19 pandemic.

This month, the finance ministry cut its 2024 economic growth forecast from 1.9% to 1.1%. The forecast for next year was reduced from 4.6 percent to 4.4 percent.

Rothenberg said that “decisive and rapid steps” should be taken to approve the 2025 state budget.

“The state budget should promote growth engines, investment in infrastructure, consideration of social needs and response to Israel’s security needs,” he added.

Government borrowing, mostly from the domestic market, increased rapidly to finance the war effort. The shekel has been resilient, thanks in large part to the central bank announcing a $30 billion package to support the currency shortly after the outbreak of war against Hamas in October.

Still, Israeli bonds took a hit. The yield on 10-year shekel notes has risen nearly 100 basis points this year, and spreads on U.S. Treasuries are at an 11-year high. Israel’s dollar bonds are among the worst-performing bonds globally compared to other government bonds, according to Bloomberg indexes.

Moody’s downgraded Israel’s rating from A1 to A2 in February; this was the first downgrade in the country’s history. Moody’s said at the time that the conflict would “materially increase political risk for Israel, as well as weaken Israel’s executive and legislative institutions and financial strength for the foreseeable future.”

At the time, Prime Minister Benjamin Netanyahu downplayed the impact of this move, which was followed by S&P Global Ratings downgrading Israel’s rating to A+ and Fitch Ratings downgrading it to A.

Hezbollah and Hamas are supported by Iran and designated as terrorist groups by the United States. Netanyahu said the army’s bombardment of Hezbollah targets would continue until Israelis displaced from northern communities returned to their homes.

Hezbollah says its attacks against Israel will not stop until a ceasefire is reached in Gaza.

(Updates to add outlook to second paragraph, government comment starting from sixth paragraph)